Mystery of Real Estate Sector in Pakistan

pakistan real estate

KARACHI : Real-estate is a major avenue for investment in Pakistan and, in terms of returns, has beaten almost all asset classes. According to the House Price Index of, houses have exhibited a compound return of almost 13% in the last 10 years. This compounded return has reached almost 18% in the last two years.

But the drivers of demand for real-estate in Pakistan are slightly different from global drivers.

It is naïve to believe that the rising price of houses results from a rise in consumption. While consumption may be one of the drivers here, it is not the most important. Why do I say this, you ask? Well, consumption in Pakistan has started to dwindle in response to contractionary monetary and fiscal policies. Although car sales and gasoline consumption has taken a noticeable dip, real-estate prices have refused to budge.

Five years ago, I wrote an article in this newspaper in which I compared Karachi, Pakistan’s real estate hub, with other metropolitan cities. In view of the traditional demand-side indicators i.e., rent-to-price ratio and salary-to-rent ratio, Pakistan’s real-estate sector seemed to have peaked; the bust of which seemed imminent.

I was amongst those waiting to watch, but the predicted circus-act never took place)

In the case of the topic at hand, Pakistan’s real-estate bubble never burst as predicted. So, why then did the “tamasha” not place or the real-estate bubble not burst? Let’s discuss the reasons

As mentioned above, in Pakistan, consumption is not the main driver of real-estate demand. Instead, real-estate demand is driven by surplus funds parked in this sector by the more affluent classes of society. Now, with the Financial Action Task Force (FATF) conditions in place, it has become very difficult to take money out of the country. Additionally, those popular destinations, ordinarily used by Pakistanis to stash away their financial surplus, are themselves grappling with the FATF and money-laundering issues. Therefore, the funds that are unable to find a way out of Pakistan have instead found a place in its real-estate market.

Let’s discuss a hypothetical transaction: Mr A wants to park funds in real-state so he purchases a plot of land from Mr B, but what will Mr B do now? Will he buy shares from this money, invest it in T-bills or pour it into his own company as a form of investment? No, he doesn’t do anything of that sort. Instead, he buys another plot of land in view of making more profit. This chain seems to continue indefinitely. This is how Pakistan’s real-estate refuels itself, becoming more and more profitable for those who can afford it.

In a movie, Kevin Spacey says ‘land is a limited resource’ and in Pakistan, a finite amount of land is chase by an apparently infinite number of buyers. So, while these buyers and sellers manage to multiply their investment every few years, the money being offered for plots is also growing exponentially. Supply, however, is naturally limited. This limited supply causes the prices to rise again, and so on and so forth.

If economic policies remain the same, there is no end in sight for this boom.

Secondly, property market investments are also an avenue for people to turn black money into white cash. This is also an important driver for real-estate as, at least, 40% of Pakistan’s economy is undocumented, hence, huge sums of money are channelled in through this avenue.

So, then what’s the problem with this?

The problem with getting on this self-refuelling real-estate bandwagon is that it is diminishing the productive potential in the country. Why would anyone want to export goods, a measure critical to our economic survival, when you can easily double the money in a few years playing golf all day.

Furthermore, the tax laws governing this area are such that these real-estate barons end-up paying infinitely lower taxes than those applicable in the corporate sector. This acts as an incentive in favour of the real-estate band wagon and also results in the government consistently being unable to collect the required amounts of tax.

Man is motivated by incentives. You cannot coerce people to export goods, especially if the incentives lie in the passive real-estate sector.

But the real-estate people need to understand that this boom, although self-refuelling, cannot go on indefinitely. Pakistan’s Balance-of-Payment (BoP) crisis is a result of the lack of incentives offered in other productive, lucrative businesses.

The nudge theory in economics can be employed to turn this situation into something that is favourable for all parties involved. Incentives must be established so that surplus capital can flows through productive businesses, especially on the export-side. IT-exports, for example, seem to be an easy, albeit important, avenue that could help lead Pakistan out of its economic mess.

If Pakistan doesn’t quickly realise the importance of stopping this self-refuelling real-estate bandwagon, our economic woes will continue to pile up.

The writer is a banker and teaches economics